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Liquidity coverage ratio: Implications and a pragmatic approach to implementation

Learn how banks can categorize and deal with Liquidity Coverage Ratio implementation challenges in four distinct phases.

Overview

Managing liquidity risk, one of the types of risk most affected by the financial crisis, has become an important strategic and tactical topic for banks and regulators. With the introduction of the liquidity standards by the Basel committee in 2010 and the mandatory liquidity rules by the US Federal Reserve System in 2013, banks face a number of new challenges when it comes to their Liquidity Coverage Ratio (LCR).

We recommend that banks categorize and deal with these challenges in four distinct phases:

Interpret regulators’ rules and intentions.

Perform a gap assessment of the bank’s client data, tools, processes and controls.

Background

Before the global financial crisis starting in 2008, liquidity was taken for granted. The assumption was that funds were always available, at no or very low cost. Proper projection models for liquidity—as opposed to those for capital planning—were not very well developed.

As a consequence, banks lacked strong liquidity practices, and business models such as state financing relied on the refinancing of long-term assets with short-term liabilities to help ensure profitability. The possibility of a lack of liquidity was not taken seriously, and when such scenarios did unfold it was too late for action. To make matters worse, short-term profitability was the only consideration driving funding and investment decisions; the long-term need for stable liquidity and sustainable profits was neglected.

Managing liquidity risk, one of the types of risk most affected by the financial crisis, has become an important strategic and tactical topic for both banks and regulators. Banks should now understand that liquidity is obtained at a price, as demonstrated by the observable increases of liquidity spreads experienced during the last couple of years. Due to this, and for the foreseeable future, there may be very few “lenders of last resort” in liquidity crisis situations, and liquidity should remain a high priority for bankers.

Analysis

Through our work with global Tier 1 investment banks, global retail banks, and financial holding companies and their subsidiaries, we have identified a number of key challenges organizations consistently face in meeting regulatory mandates, including the liquidity standards introduced by the Basel committee in 2010 and the Liquidity Coverage Ratio (LCR) mandated by the US Federal Reserve System in 2013.

We recommend that banks implementing an LCR project categorize and deal with these challenges in four distinct phases:

Interpret regulators’ rules and intentions. Consider the bank’s specific business and operating model, starting with a complete liquidity balance sheet, including off balance sheet positions—pure balance sheet values and more importantly, all cash flows linked to the respective positions.

Perform a gap assessment of the bank’s client data, tools, processes and controls. Document the impact of regulatory guidance on LCR production, and identify key challenges and next steps.

Implement the calculations. Source all the data required for the LCR calculations and implement a reporting routine that accounts for initial compliance as well as sustainability in the long term.

Embed the LCR concept into liquidity management. Develop an operating model that integrates both regulatory and internal liquidity reporting into the broader context of risk management and risk reporting. Incorporate LCR reporting and the liquidity risk management framework into balance sheet management, along with stress testing and profit optimization.

Recommendations

Accenture encourages organizations to take steps to understand the possible implications of LCR requirements and their linkages to capital held to cover other risks, as well as balance sheet components and the earnings related to these requirements. This requires well-directed efforts to integrate liquidity risk management into the bank’s processes seamlessly—across multiple functions and teams at the bank—and to manage liquidity appropriately, aligning it with capital and earnings targets.

Modern liquidity management not only helps with cash flow projection but also provides important input into the strategic decision-making process, including:

Sources of funding under business as usual and stress scenarios.

Stability of funding sources.

Contingency funding planning.

Identifying stress scenarios.

Under all stress scenarios—whether prescribed by regulators or conceived by the bank—a sufficiently high LCR will affect investment and funding decisions in ways that go beyond mere compliance. While the reporting and analysis is mandated, banks that undertake liquidity risk management in a comprehensive, strategic manner will be best-positioned to benefit from the results.

Authors

Bjørn Pettersen is a managing director, Accenture Finance & Risk Services. Based in New York, Bjørn has over 20 years of extensive and deep experience in the financial services sector working with major global banks and insurers, Wall Street financial institutions, exchanges and regulators. With a focus on risk management and compliance, he has led high profile risk and regulatory-focused consulting engagements, business strategy and operating model transformations, in addition to merger integration assignments for clients on the journey to high performance.

Gerald Hessenberger is a senior principal, Accenture Finance & Risk Services. Based in Zurich, Gerald brings 20 years of working experience in the areas of operational ALM (banks and insurance companies), banking book management and bank controlling, asset and loan pricing, risk analysis and management, and asset management. His deep experience in the functional design and modeling of pricing and risk tools as well as risk processes related to trading, hedging, value-based management and enterprise risk management helps clients in Europe, Asia and North America become high-performance businesses.

Akber Merchant is a senior manager, Accenture Finance & Risk Services. Based in New York, Akber has solid consulting and industry experience in financial services and risk management. He has worked with global and regional financial institutions across North America, Asia and Europe to improve business performance and enhance risk management capabilities.

Mark Wilson is a senior manager, Accenture Finance & Risk Services. Based in New York, Mark has a broad range of risk and regulatory project experience across Europe and the United States. His delivery experience, establishing and implementing solution designs across business and technology has helped deliver LCR reporting solutions at large banking institutions in London and New York. Mark brings deep industry knowledge of payments, treasury services and trading products across multiple regions to assist clients in establishing effective solutions to their regulatory requirements.

Amir Kumar is a manager, Accenture Finance & Risk Services. Based in Gurgaon, India, Amir is a risk management professional with over 9 years of experience in multiple areas of risk management and regulatory compliance working with a broad range of financial services clients across multiple regions. His strong experience in Basel II/III solution architecture and implementation, liquidity risk management, operating model design, credit risk frameworks, early warning systems and risk analytics helps clients become high performance businesses and comply with regulatory requirements and guidelines.

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